January 4, 2023
A Win-Win for Investors and Managers: Bypassing Feeder Funds Through Technology
Feeder funds have traditionally been one of the few ways that high net worth retail investors could access alternative investments, as alternative fund sponsors typically limited fund raising to only a small number of large LPs. That intermediation, however, comes at a high cost, both for investors, who must pay higher fees without benefit of the white glove experience and service of being an LP, and for the alternative asset manager, who loses control of the sales process and the relationship with the ultimate investor. As investors seek more direct access to alternatives and managers look to continue growing their franchises by expanding directly into the fast-growing retail market, technology is making it increasingly possible to bypass feeder funds
High net worth retail investors seeking enhanced risk-adjusted return and diversification for their portfolios have been a driving force in the rapid growth of the alternative investment market in recent years. For a long time, feeder funds were their only option. But, feeder funds are expensive, often charging 40 or 50 basis points in fees. To add insult to injury, those high fees bought investors “second class status”, as customers of the feeder fund without direct access to the first-class service managers accord LPs.
For their part, alternative asset managers, accustomed to highly manual, highly paper-based and highly bespoke processes for raising funds and servicing a few large, institutional LPs, saw feeder funds as a convenient, albeit costly, distribution channel, though one that meant giving up control of the sales process and relationship with the end investor. For their part, alternative asset managers were willing to learn about the HNW market via feeder funds due to the size of the market segment ($50T) and under allocation to alternatives1. Initially, this approach made sense as it offered alternative managers a means to develop relationships and the infrastructure required to reach HNW investors. But that is changing as access is improving and alternative managers are emphasizing the HNW channel as their fastest growing revenue opportunity across the global market.
Technology now enables investors and managers to bypass feeder funds in a win-win for both which signals a major evolution in the industry.
Managers can now integrate all their front, middle and back office functions, from onboarding investors and capital calls to portfolio management and distribution, on a single automated platform that dramatically speeds up the process, enables global compliance, allows servicing far more investors, and is cost-efficient. For investors, this means greatly expanded access to alternatives and the LP experience at lower fees and lower minimums.
While some fund structures (3c1 and to a lesser extend 3c7’s) are required to limit the number of investors and some managers may be slow to replace their tried-and-true processes, no matter how archaic, technology is leveling the alternative investment playing field and redefining who gets to be an LP.
1 Source: McKinsey: “Private markets rally to new heights: McKinsey Global Private Markets Review 2022.”